ACCOUNTANCY AGE PERSONAL FINANCE SPECIAL: Policies that are no longer well-endowed

Each year, at about this time, a familiar financial ritual asserts itself for about five million endowment policyholders.

The life insurance companies they invest through send out letters telling them how much their bonuses are going to be worth.

For a smaller but substantial number of individuals, the letters have added significance: they give details of how their policies will pay out in total when they mature this year.

By the end of March at least 25 companies will have announced their bonus results.

Endowment policies have had a rough time lately. More and more providers including Barclays, NatWest, Scottish Widows, Pearl, HSBC, Lloyds, Abbey National and even Co-operative Insurance Services (CIS) have announced they are pulling out of the market.

The reason for this is the growing concern that many policies sold over the past 10 to 15 years won’t deliver enough at maturity to pay off the mortgages they were intended to. It is even less likely that a policy taken out today will do so 25 years down the line.

Supporters of endowments have always argued that if investors hold a policy to the end of its term, returns can be good. Perhaps, but it is proving to be an increasingly less tenable argument.

Norwich Union, one of the UK’s largest insurers gave a flavour of problems likely to be faced by endowment holders when it announced payouts to 70,000 of its own policyholders whose investments are maturing this year.

Someone paying £50 a month into a 25-year endowment maturing this year would receive £89,518. This compares with £98,037 for a person whose endowment matured 12 months earlier.

Annual bonuses, which cannot be taken away, are 1.5% on the guaranteed element of a policy (the minimum payout made if a person dies) and 2.75% on normal attaching bonuses. This is a drop of 0.5% compared to last year.

Friends Provident, another insurer which recently announced its bonus results, also cut rates from £106,434 last year to £102,341 today for the same type of policy.

Richard Harvey, group chief executive at Norwich Union, justifies the decision to cut payouts: ‘Against a wider background of lower interest rates and low inflation, our view of longer-term investment outlook has led us to further adjust bonus levels. We believe annual bonuses need to be managed at a realistic level, which allows us the investment freedom to maximise the overall investment return.’

His comments reflect the dilemma faced by increasing numbers of insurers.

Maturity payouts on endowments are formed from a mixture of annual bonuses, which cannot be taken away once added, and a large terminal bonus. If you add a large annual bonus to a policy, your life fund must have adequate funds to meet that liability when it falls due. Therefore that slice of money must be invested in a safe – but low-returning – haven even if it may not be paid out for another decade or more.

By cutting annual bonuses you can invest more in the stock market, where potential gains are highest – but only at a greater risk, which itself goes against the grain of what endowments are meant to be about: security.

It also makes many endowments even more opaque in their structure: if you can’t work out what you are going to get until 25 years down the line, why bother?

The problem is exacerbated by an announcement from the Personal Investment Authority last year that if you are selling an endowment, its projected returns must be based on assumed rates of growth of 4, 6 or 8%. This compares with old projections of 5, 7.5 and 9%. Many companies worked out what policyholders should be paying on the basis of the older projections – and higher growth rates implied you had to pay less, after charges were taken into account. Now you have to pay more.

Indeed, the situation is worse because until five years ago, companies did not even have to base their policyholders’ premiums on the basis of their own charges, but a so-called ‘average’ for the industry. And for many insurers, the average was better than their own charges – which means returns may be even worse.

Hardly surprising, therefore, that many companies have pulled out of selling endowments. Martin Clarke, general manager at CIS, reflects assumptions that returns will fall: ‘Our decision has been made after a careful review. Many experts think that an average future yield of 6 or 7% is not unreasonable and we do not disagree with them. We believe that all our existing policies remain at present on course to cover their mortgages.’

That, however, applies to companies with relatively low-charging endowments.

For those with heavy annual fees of 3% or more – half of any annual growth will be swallowed up in management costs.

The implication is that increasing numbers, perhaps as many as one million out of the total of five million endowment policyholders, will not receive enough at maturity to pay off their mortgages unless they increase contributions into their schemes.

Should they? Increasingly, the answer is no.

It makes sense to continue payments into your existing scheme. But the heavy extra charges – even for increasing contributions – and growing insecurity and inflexibility means they are not seen as suitable as a mortgage repayment vehicle.

The endowment in its current form is dead. Shame that it took millions of badly burned policyholders to determine its final outcome.

Is the roof set to fall in on Internet shares?

Related reading